I’m confusing myself, someone please help.

i know ALM is used when a person or company had definable liabilities, and ALM helps match the duration of portfolio assets and liabilities. What’s confusing is surplus ALM which try’s to maximize the surplus btw assets and liabilities. How are you maximizing surplus but matching duration at same time??



you are projecting assets and liabilities.

asset after X ( let say 10yr, industry standard) year will be at a certain level and liabilities will be at Y level.

X-Y is your surplus after the 10 yrs, you test multiple (1000) 10yr economic scenario under 1 portfolio. you check the average surplus and the volatility of surplus for that given portfolio over the 1000 final value.

you change the portfolio, you re-do the 1000 economic scenario with that portfolio, you check the average surplus and the volatility of surplus for that given portfolio.

continue thos step until you have tested a good amount of portfolio.

now each portfolio will have his own expected surplus and volatility of surplus, you chose the one that maximise the surplus for a giving volatility of surplus.

you now have a efficient frontier. based on average surplus and volatility of surplus

I did not answer your main question.

the portfolio may be 50% fixed income and 50% equity,

you can match 100% of you duration with 50% equity. you just need to use higher duratio instrument and/or leverage,

so you can test multiple set of bond/equity

also you can test multiple equity combinaition ( 50% us 50% world, 100% world… etc )

in the end you will have test maybe 1000 portfolio and you take the one that maximise surplus / risk of surplus

Or u can take the ratio of assets/ liab instead of surplus and plot against its variability ( on the xaxis)

This is or allocation ( efficient frontier)

Maybe I’m confusing matching duration and return. Just because you match duration of a portfolio and liabilities doesn’t mean you can’t earn a return that increases the difference in assets and liabilities, correct?

best case scenario : you have a perfect hedge and you earn excess return over the liability.

if you find undervalued security with the same duration, this means that you will earn a higher yield than your liability, which in fact is perfect.

yield on portfolio doesnt have to be the same for perfect match.

I guess after reading the fixed income section, I tended to think of ALM as only using fixed income securities but that’s not the case? You just want to match the duration of the liability but that can be done with a combination of assets?? In the process too, you can also earn a higher return inove what’s needed to meet liabilities?

That sound accurate?

thanks again

Asset can be anything you want. the ALM process is comparing a giving asset portfolio evolution at the same time as the liability evolution for a giving scenario. so once you know how both react to economic changes, you can allign them ( allign them perfectly, not perfectly, not at all… as u wish )

even if they are very very far from each other, and you do scenario analysis incorporating both assets and liability, well you are doing a ALS ( asset liability study )

when you are incorporating both measure, it is much more easier to allign your portfolio with your liability.

oh BTW

ALM is Asset liability Management, not asset liability matching

from CFAi

Asset/liability management (ALM) approach In the context of determining a strategic asset allocation, an asset/liability management approach involves explicitly modeling liabilities and adopting the allocation of assets that is optimal in relationship to funding liabilities.

(Institute G-1)

Institute, CFA. Level III 2013 Volume 4 Fixed Income and Equity Portfolio Management. John Wiley & Sons P&T, 6/18/2012. .